Commonwealth General Purpose Financial Assistance to Local Government (October 2003)


Research Paper Index

Research Paper no. 1 2003-04

Commonwealth General Purpose Financial Assistance to Local Government (October 2003)

Richard Webb
Economics, Commerce and Industrial Relations Group
11 August 2003 (revised 27 October 2003)

Interstate Distribution
Combining Identified Road Grants and General Purpose Grants
Roads to Recovery Grants

Glossary

Financial assistance grants: the term used to describe jointly general purpose grants and identified local road grants.

Fiscal equalisation: with respect to the States, (full horizontal) fiscal equalisation is the provision of financial assistance which, as assessed by the Commonwealth Grants Commission, is designed to provide a State with the capacity to provide services at a standard comparable with those of the other States but without requiring that State to impose a greater burden of taxation. As applied to local government, fiscal equalisation seeks to ensure that each local government in a State can function, by reasonable effort, at a standard not lower than the average standard of other local governments in the State. Fiscal equalisation takes account of differences in local governments' expenditure requirements and capacity to raise revenue.

General purpose grants: payments that local government can use for any purpose. They are distributed among the States on an equal per capita basis.

Grants: non-repayable, non-interest bearing assistance.

Identified local road grants: untied grants to local government. Identified local road grants were previously paid as specific purpose payments under the Australian Land Transport Development Act 1988 and distributed among the States on the basis of criteria established under this Act. The payments were untied with effect from 1 July 1991. Identified local road grants are distributed among the States in the same proportions that existed when the grants were untied in 199192. (See also specific purpose payments and untied grants).

Local government: a body established under State legislation, which delegates various functions to that body. Local government thus forms part of and is an extension of the State government sector. Also includes a body declared to be a local governing body under the Local Government (Financial Assistance) Act 1995.

Specific purpose payments: payments for policy purposes related to particular functional activities, for example, health and education. Specific purpose payments are made under section 96 of the Constitution, which states that the Parliament may grant financial assistance to any State on such terms and conditions as may be specified. (See also untied grants).

Untied grants: payments to which no conditions on use are attached. (See also specific purpose payments).

Executive Summary

Local government is a small but important part of the public sector, being responsible for providing a wide range of services. The ability of local government to provide services depends partly on Commonwealth financial assistance grants. These take two forms: general purpose grants, and grants for roads known as identified local road grants. Commonwealth financial assistance grants account for around 12 per cent of local government revenue.

However, the way the Commonwealth determines the level of assistance and how assistance is distributed among local governments are not widely understood. This paper seeks to help Parliamentarians improve their understanding of how current arrangements have evolved and of their limitations. A particular focus is the level of the grants and their interstate distribution. The paper also discusses payments made under the Roads to Recovery Act 2000 because they are also spent on local roads. Grants under the roads to recovery program are specific purpose payments that the Commonwealth pays directly to local governments.

The Commonwealth has provided financial assistance to local government since 197475. Local governments can use general purpose grants for any purpose. While, in principle, local governments can spend identified local road grants for any purpose, in practice, they spend the grants on roads. The Commonwealth pays assistance 'through' the States, that is, on condition that the States pass the funds to local government. State Grants Commissions determine the allocation of funds among local governments within their respective States.

Commonwealth financial assistance has been declining as a proportion of gross domestic product (GDP) since at least 199192. In the absence of action to change the situation, this trend will continue. The Local Government (Financial Assistance) Act 1995, which governs the provision of financial assistance, provides for the level of assistance to be increased annually in accordance with rates of population growth in each jurisdiction and changes in the consumer price index. This formula maintains the per capita value of assistance in real terms and places a 'floor' under the level of assistance. But the formula does not provide growth in the real level of per capita assistance, and because GDP has grown faster than assistance, the level of assistance has fallen as a proportion of GDP. The Australian Local Government Associationthe body that represents local government at the national levelargues that the level of financial assistance should be increased and set at one per cent of total Commonwealth taxation receipts. In 200102, application of this proposal would have resulted in assistance of $1.498 billion compared with actual assistance of $1.394 billion. Under this proposal, the level of grants would, however, fluctuate with economic activity and discretionary changes to taxation rates.

The contrast between Commonwealth financial assistance arrangements for the States and local government is striking. The States have access to a source of general purpose assistance, namely, the goods and services tax (GST). Revenue from the GST is likely to increase in line with growth in the economy. In contrast, local government does not have access to such a 'growth tax'. This has led, among other things, to calls for local government to be allocated a proportion of GST revenue. An argument underlying these calls is that because local government is the creation of the States, the States should be responsible for ensuring that local government has adequate funding but have failed to do so. The States would be likely to resist any move to earmark a proportion of GST revenue for local government. Further, the Howard Government's policy is not to change the GST agreement between the Commonwealth and the States and Territories.

The roads to recovery program has boosted spending on local roads substantially (estimated spending to 30 June 2003 exceeds $650 million). The Roads to Recovery Act 2000 provides $1.2 billion in specific purpose payments made directly to local government for the construction, upgrading and maintenance of roads by 30 June 2005. In annual average terms, $1.2 billion over five years is equivalent to an additional $240 million or the equivalent of 52 per cent of the $464 million allocated to identified road grants in the 200304 Budget.

It could be argued that the roads to recovery funds could be better used to increase general purpose grants on the grounds that local governments are best placed to determine their priorities and can spend general purpose grants in accordance with those priorities. But the Australian Local Government Association favours the continued separation of identified road grants from general purpose grants on the grounds that combining the two would see large changes in the distribution of the funding among the States, and lead to volatility in the grants provided to local governments. Moreover, local governments spend more on local roads (in excess of two billion dollars annually) than is funded by identified road grants, so that much of any additional funds in the form of general purpose grants would be likely to be spent on roads.

The interstate distribution of financial assistance grants to local government differs from that which would exist if the basis of distribution were fiscal equalisation. In this respect, Commonwealth assistance to local government differs from assistance to the States where the Commonwealth Grants Commission, in allocating revenue from the goods and services tax among the States, aims to achieve fiscal equalisation.

The interstate distribution of general purpose grants is on an equal per capita basis. The Commonwealth Grants Commission concluded in a 1991 report that it would not be appropriate to continue this method indefinitely because it departs from fiscal equalisation. But the Commission also observed that distributing general purpose grants on a fiscal equalisation basis would be disruptive since this would entail redistributions of funds among the States and local governments.

Identified road grants are distributed among the States on the basis of the shares that existed when the grants were untied in 199192. The distribution is thus increasingly anachronistic. The Government decided against using these shares for the roads to recovery program. The interstate distribution of roads to recovery grants takes account of road length, population and other factors. While the interstate distribution of roads to recovery grants is similar to the distribution of identified road grants, Victoria, Queensland and South Australia benefit relative to the allocation of identified road grants.

Political considerations seem to militate against changing the distribution of financial assistance among the States. A major change in the basis of distribution would entail disruption with some Statesand hence some local governmentslosing funds and others gaining.

The Local Government (Financial Assistance) Act 1995 requires the State Grants Commissions to allocate Commonwealth assistance among local governments on the basis of agreed national principles. The objective of the principles is to ensure that the Commissions distribute grants on a nationally consistent basis. The main principle is fiscal equalisation, which seeks to improve the equity of grant outcomes. But it is questionable to what extent equalisation is being achieved. The State Grants Commissions do not use consistent methodologies to determine intrastate allocations. Moreover, it is questionable whether some of the methodologies meet the objective of fiscal equalisation. Further, the national principles seem to be internally inconsistent. In particular, the principle allowing local governments to receive minimum grants seems to be contrary to fiscal equalisation.

The Commonwealth Grants Commission reviewed the operation of the Local Government (Financial Assistance) Act 1995. In its June 2001 report, the Commission found, among other things, that:

  • the types of services that local governments provide have broadened and shifted towards human services. Changing priorities and the imposition of additional functions by the other tiers of government ('cost shifting') account for the changes
  • current arrangements have broadly achieved the Act's purposes and goals: some are being achieved but others are not
  • the underlying intention of the horizontal equalisation principle is being implemented but horizontal equalisation is not and cannot be achieved
  • State Grants Commissions should change their methodologies to achieve more effective equalisation
  • a concept of relative need based on equalisation principles should replace the term horizontal equalisation in the Act, and
  • State governments, in particular, are shifting responsibilities onto local governments without providing additional commensurate revenue.

The Commission recommended that three assistance pools be established: the per capita grant pool, the relative need pool, and the local roads pool. The per capita pool would provide each local government with the same amount per capita and replace the minimum grant principle. The purpose of the relative need pool would be to assist disadvantaged local governments; distribution would be based on assessments of relative need in turn based on equalisation principles. The per capita and relative need pools would be funded from general purpose grants, with 30 per cent of each State's general purpose grants allocated to the per capita pool and 70 per cent to the relative need pool. The local roads pool would be distributed among local governments on the basis of relative road needs, which would relate to the cost of maintaining an existing road network. These changes would not, of themselves, result in a change in the grants paid to local governments but would improve the transparency of current arrangements.

The Government did not formally respond to the Commission's report but drew on it particularly the cost shifting by the States. The Howard Government's election commitments on local government included an undertaking to inquire into the incidence of cost shifting onto local government by the States and, on 30 May 2002, the Government announced that the House of Representatives Economics, Finance and Public Administration Committee would inquire into cost shifting and the financial position of local government. This Inquiry is specifically tasked with examining the recommendations of the Commonwealth Grants Commission's review of the operations of the Local Government (Financial Assistance) Act 1995. It is expected that the Committee's report will be tabled later this year.

Introduction

The Commonwealth has provided financial assistance to local government since 197475. Financial assistance grants take two forms: general purpose grants and untied local road funding known as 'identified local road grants'. The legislative authority for general purpose grants and identified local road grants(1) is the Local Government (Financial Assistance) Act 1995. Local governments can use general purpose grants for any purpose. In principle, local governments can also spend identified road grants for any purpose but, in practice, spend the grants on roads.

General purpose grants are distributed among the States on an equal per capita basis. Identified road funds are, in effect, distributed on the basis of criteria established under the Australian Land Transport Development Act 1988 (see discussion below under untying of local road funds and identified road grants). The Local Government (Financial Assistance) Act 1995 requires the State Grants Commissions to allocate general purpose grants and identified road grants among local governments on the basis of 'national principles'. The main purpose of these principles is to ensure that the Commissions distribute grants on a nationally consistent basis.

This paper traces the evolution of Commonwealth financial assistance to local government and discusses related issues including:

  • the level of assistance
  • the interstate allocation of assistance
  • the treatment of identified road grants
  • the application of the national principles
  • State Grant Commission methodologies, and
  • the extent to which actual grant allocations are consistent with fiscal equalisation.

In 200001, the Commonwealth began to make specific purpose payments under the Roads to Recovery Act 2000 for the construction, upgrading and maintenance of roads. The paper discusses these grants because they are also spent on local roads. The paper does not discuss other specific purpose payments made directly to local government for 'policy' purposes (see Box 1).

Box 1: Specific Purpose Payments Made Directly to Local Government Authorities

The Commonwealth pays current and capital specific purpose payments directly to local governments for purposes such as health and education. Examples of current payments are funds for the provision of residential and community-care services for the frail aged and services for people with disabilities. Examples of capital payments are funds for constructing community child care centres. The 200304 Budget allocates $1508.4 million towards general purpose assistance compared with specific purpose payments made directly to local governments of $789 million (including $300 million for roads to recovery).(2)

History of Financial Assistance(3)

Whitlam Government

The Commonwealth first provided financial assistance to local government in 197475 in line with the Labor Party's policy of providing assistance to local government to promote equality among regions, and to ensure adequate services and the development of resources at local and regional levels. The Grants Commission Act 1973 authorised the Commonwealth Minister to approve the establishment of regional organisations to represent local governments located in the region, and laid down procedures for the organisations to apply for financial assistance. The Act further provided for the Commonwealth Grants Commission to inquire into and report on applications. In the event, the Government distributed the grants among local governments in each State in accordance with the Commission's recommendations. In the following two years, the Commission assessed the applications and the Government again accepted the Commission's recommendations.

Tax Sharing Arrangements

In 1975, the Liberal-National Country Party coalition adopted the provision of assistance to local government as part of its federalism policy. The arrangements the Whitlam Government had put in place changed with the election of the Fraser Government and its 'new Federalism' policy of sharing personal income tax revenue among the Commonwealth, State and local governments. Under the provisions of the Local Government (Personal Income Tax Sharing) Act 1976, local government received in 197677 the equivalent of 1.52 per cent of net personal income tax collections in the previous year. In November 1977, the Prime Minister, the Hon. Malcolm Fraser MP, announced the Government's intention to increase this proportion to two per cent over the following three years. In the event, the proportion was increased to 1.75 per cent in 197980 and to two per cent in 198081. The method of allocation of grants among the States was changed from full equalisation to a method based partly on per capita grants (the so-called minimum grant) and partly on equalisation.(4) Responsibility for determining the intrastate distribution of grants of the part-equalisation component was passed to the newly-created local government Grants Commissions established by the States. The sharing of personal income tax receipts continued through to 198485.

Hawke Government

The Hawke Government dropped these arrangements, arguing that the economy could not afford tax sharing with the States and local government. Instead, the Government increased local government assistance in 198586 by the change in the consumer price index and an additional two per cent growth factor over the 198485 level. The distribution among the States remained the same as that specified in the Local Government (Personal Income Tax Sharing) Act 1976.

Self Report and the 1986 Act

On 10 May 1984, the Government announced the establishment of a Committee of Inquiry into Local Government chaired by Professor Peter Self. The Committee's terms of reference were wide-ranging including the level and form of Commonwealth funding. The Committee presented its report on 29 October 1985.(5) In April 1986, the Government announced that it had accepted the thrust of the report and that arrangements for the provision of assistance would change from 198687 onwards. The new arrangements closely followed the Inquiry's recommendations.(6) Key features of the new arrangements, contained in the Local Government (Financial Assistance) Act 1986, were:

  • financial assistance grants replaced personal income tax sharing
  • in 198687, grants were to be increased by the greater of either the 198586 level of assistance adjusted for inflation (that is, a 'real terms' guarantee) or the percentage change in general purpose payments to the States
  • for 198788, the level of assistance was to be determined by the same means as for 198687 but using 198687 payments as the base
  • in following years, the level of assistance to local government would be linked to the level of assistance to the States, whereby the annual level of local government assistance would be determined by increasing the amount paid in the previous year by the percentage change in general purpose payments to the States(7)
  • the distribution of assistance among the States was to be phased from existing arrangementswhich were still partly based on the recommendations of the Commonwealth Grants Commission made in 1977to an equal per capita basis by 198990
  • the State Grants Commissions were to determine the intrastate distribution of grants according to principles, formulated by each State, that took fiscal equalisation into account
  • all local governments would be entitled to a minimum grant based on population,(8) and
  • provision was made for informal local government bodies, such as Aboriginal communities in remote areas, to receive grants.

Local government benefited from the 'real terms' guarantee in 198687 and 198788 because grants to the States fell in real terms in those years, but suffered cuts in real terms in 198889, 198990 and 199091 when real State general purpose funding fell.

The interstate distribution of local government assistance in 198889 reflected the transition to equal per capita grants. In 198990, grants were distributed on an equal per capita basis.

Commonwealth Grants Commission 1991 Report on the Interstate Distribution of Grants

Despite the decision to allocate grants on an equal per capita basis, the 1989 Premiers' Conference agreed that the Commonwealth Grants Commission should report on the interstate distribution of general purpose grants to local government. The Commission's two main tasks were to comment on the desirability of adopting full fiscal equalisation (as distinct from the part-equalisation under the Fraser Government noted above) and to calculate what the distribution of grants would be if full fiscal equalisation were adopted. The Commission's report was released in March 1991.(9) The Commission supported, in principle, the adoption of fiscal equalisation:

In principle, we believe it would not be appropriate to continue indefinitely an interstate distribution of general purpose assistance for local government on a basis (equal per capita) which departs so markedly from fiscal equalisation.(10)

But the Commission recommended against using the per capita relativities that it had assessed for allocating assistance for local government among the States in 199192 because of data and methodology deficiencies.(11)

The Premiers' Conference of 31 May 1991 considered the Commission's report. Given the Commission's concerns, the Commonwealth announced in May 1992 that grants would continue to be distributed on an equal per capita basis. Hence general purpose grants have continued to be distributed on this basis since 198990.

Untying of Local Road Funds and Identified Roads Grants

Until 199091, the Commonwealth provided specific purpose grants to local government for local roads under the Australian Land Transport Development Act 1988. The grants were distributed on the basis of criteria in this Act. The October 1990 Special Premiers' Conference agreed that road funds would be untied with effect from 1 July 1991, that is, the conditions applying to road grants would be abolished and local governments could spend the funds for any purpose. The untied grants are called identified local road grants.(12)

In June 1991, the Local Government (Financial Assistance) Act 1986 was amended to allow road funding to be added to general purpose grants from 199596 and hence distributed on a per capita basis. But this would have been to the detriment of Western Australia, Tasmania, the ACT, the Northern Territory and Queensland.(13) The 1995 Premiers' Conference therefore decided that local road funds would continue to be distributed on the basis of the criteria in the Australian Land Transport Development Act 1988.(14) The effect of this decision has been to freeze the interstate distribution of identified local road grants at the historical shares that applied in 199192 when grants were untied.

Review of the 1986 Act

In June 1993, local government Ministers agreed to a review of funding arrangements to ensure an efficient and effective use of resources under the Local Government (Financial Assistance) Act 1986 given the level of funding and distribution of funds among the States. The Australian Urban and Regional Development Review undertook the study.(15) The review's findings included:

  • there had been a shift in the share of funding to rural councils in all States (except Victoria) and the Northern Territory
  • State Grants Commissions were following two models of fiscal equalisation: in one, an increasing share of funds was allocated to local governments with increasing populations whereas in the other model, the reverse was true
  • in most States, an increasing share of assistance went to local governments with the greatest socio-economic disadvantage
  • the need for a uniform national reporting framework was urgent
  • absorbing local road funding into general purpose grants and hence distributing road funding on an equal per capita basis would be disruptive and was not recommended, and
  • additional measures to encourage efficiency in local government should be implemented.

Local Government (Financial Assistance) Act 1995

Following consideration of the review and consultations with State and local governments, the Commonwealth undertook further reforms, which were contained in the Local Government (Financial Assistance) Act 1995. This Act retained most of the features of the 1986 Act. The main change was the requirement that national principles replace the arrangements whereby each State formulated principles. The main objective of the national principles (see Box 2) was to establish a more nationally consistent and transparent basis for the way State Grants Commissions determine the intrastate allocation of funds.

Box 2: National Principles Relating to the Allocation of Grants

1. The national principles relating to the allocation of general purpose grants are:

(i) Horizontal equalisation. General purpose grants will be allocated to local governing bodies, as far as practicable, on a full horizontal equalisation basis as defined by the Act. This is a basis that ensures that each local governing body in the State/Territory is able to function, by reasonable effort, at a standard not lower than the average standard of other local governing bodies in the State/Territory. It takes account of differences in the expenditure required by those local governing bodies in the performance of their functions and in the capacity of those local governing bodies to raise revenue.

(ii) Effort neutrality. An effort or policy neutral approach will be used in assessing the expenditure requirements and revenue-raising capacity of each governing body. This means as far as practicable, that policies of individual local governing bodies in terms of expenditure and revenue effort will not affect grant determination.

(iii) Minimum grant. The minimum general purpose grant allocation for a local governing body in a year will be not less than the amount to which the local governing body would be entitled if 30 per cent of the total amount of general purpose grants to which the State/Territory is entitled under section 9 of the Act in respect of the year were allocated among local governing bodies in the State/Territory on a per capita basis.

(iv) Other grant support. Other relevant grant support provided to local governing bodies to meet any of the expenditure needs assessed should be taken into account using an inclusion approach.

(v) Aboriginal peoples and Torres Strait Islanders. Financial assistance shall be allocated to councils in a way which recognises the needs of Aboriginal peoples and Torres Strait Islanders within their boundaries.

2. The national principle relating to the allocation of the identified road component of the general purpose grants is:

Identified road component. The grants should be allocated to local governing bodies as far as practicable on the basis of the relative needs of each local governing body for roads expenditure and to preserve its road assets. In assessing road needs, relevant considerations include length, type and usage of roads in each local governing area.

Other changes to the 1986 Act included:

  • recognition of the need for local government to be efficient and effective
  • recognition of the need to improve the provision of services to Aboriginal and Torres Strait Islander communities
  • the requirement that the Commonwealth Minister with portfolio responsibility for administering Commonwealth financial assistance to local government, report annually to Parliament on the operation of the 1995 Act, and
  • the requirement that a review of the 1995 Act be carried out by 30 June 2001.

The 25 March 1994 Premiers' Conference decided that financial assistance grants paid to the States would be maintained in real per capita terms over the next three years. This decision affected local government grants because the 1995 Act provided for local government financial assistance to be increased annually by an escalation factor that reflected the underlying movement in general revenue assistance paid to the States. The escalation factor for State grants reflected indexation for population growth and the consumer price index. The consequence of the Conference decision was to maintain the level of grants in real per capita terms and thereby place a 'floor' under the value of assistance.

A New Tax System

As part of A New Tax System (ANTS), the Howard Government proposed that the States assume responsibility for providing financial assistance to local government from 1 July 2000.(16) Payments were to be made under the terms of the Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations, that heads of government signed at the 1999 Premiers' Conference. But under the agreement between the Government and the Australian Democrats to modify the goods and services tax (GST) and implement a package of other proposals, the Government agreed to retain responsibility for assisting local government.(17)

The Howard Government's decision to replace financial assistance grantsand revenue replacement payments(18)to the States with revenue from the GST from 1 July 2000 severed the link between grants to the States and grants to local government established in the 1986 Act. The Government therefore introduced the Local Government (Financial Assistance) Amendment Act 2000. The main purpose of this Act was to maintain the level of assistance to local government in real per capita terms.(19) Thus since 200001, the increase in financial assistance has been based on an escalation factor based on population growth and the increase in the consumer price index but excluding the estimated effect of the tax reform measures in The New Tax System.(20)

Local governments can claim input tax credits for the GST. It seems likely that local government, overall, obtained savings from the implementation of the GST.(21)

Commonwealth Grants Commission 2001 Review of the 1995 Act

As noted, one of the changes to the 1986 Act was the requirement that a review of the 1995 Act be carried out by 30 June 2001. On 1 June 2000, the then Minister for Finance and Administration, the Hon. John Fahey, directed the Commonwealth Grants Commission to review the operation of the 1995 Act. The terms of reference are set out in Appendix 1. Broadly, they asked the Commission to examine:

  • whether the Act's goals are being achieved
  • the appropriateness of the national principles
  • how local government functions have changed, and
  • whether the State Grants Commissions' methodologies are consistent with the national principles.

The Commission reported on 18 June 2001.(22) Its main findings and recommendations were:

  • the types of services that local governments provide have broadened and shifted towards human services. Changing priorities and the imposition of additional functions by the other tiers of government ('cost shifting') account for the changes
  • current arrangements have broadly achieved the Act's goals although some are being achieved and others not
  • the underlying intent of the horizontal equalisation principle is being implemented but horizontal equalisation is not and cannot be achieved
  • State Grants Commissions' methodologies are not consistent with the intentions underlying the national principles in all respects, so changes are required to achieve more effective implementation of equalisation
  • a concept of 'relative need based on equalisation principles' should replace the term horizontal equalisation in the Act
  • three pools should be established: the per capita grant pool, the relative need pool, and the local roads pool
    • the per capita pool would provide each local government with the same amount per capita; this pool would replace the minimum grant principle
    • the purpose of the relative need pool would be to assist disadvantaged local governments; distribution among local governments would be based on assessments of relative need in turn based on equalisation principles
    • the per capita and relative need pools would be funded from the general purpose grants, with 30 per cent of each State's general purpose grants allocated to the per capita pool and 70 per cent to the relative need pool, and
    • the local roads pool would be distributed among local governments on the basis of relative road needs, that would relate to the cost of maintaining an existing road network.

These changes would not, of themselves, result in a change in the grants paid to local governments but would improve the transparency of current arrangements.

The terms of reference specifically precluded the Commission from examining the level of assistance and its interstate distribution. This limited the value of the review because they are two major issues (see the discussion below under 'issues in Commonwealth assistance'). That said, the Commission's report is an extremely valuable contribution to achieving a more rational allocation of Commonwealth assistance to local government.

House of Representatives Committee on Local Government and Cost Shifting

The Government did not formally respond to the Commission's report but drew on it. The Howard Government's election commitments on local government included an undertaking to inquire into the incidence of cost shifting onto local government by the States. On 30 May 2002, the then Minister for Regional Services, Territories and Local Government, the Hon. Wilson Tuckey, announced that the House of Representatives Economics, Finance and Public Administration Committee would inquire into cost shifting and the financial position of local government.(23) This Inquiry is specifically tasked with examining the recommendations of the Commonwealth Grants Commission's review of the operations of the Local Government (Financial Assistance) Act 1995. It is expected that the Committee's report will be tabled later this year. The terms of reference are set out in the Appendix 2.

Issues in Commonwealth Assistance

The Commonwealth Grants Commission's discussion paper, prepared for its review of the Local Government (Financial Assistance) Act 1995, listed 15 issues on which it specifically sought views. The following examines some of these and other issues in Commonwealth assistance to local government.

Level of Assistance

Local governments see the level of Commonwealth financial assistance as a major issue (such assistance accounts for around 12 per cent of local government revenue).(24) The amounts of assistance since 199192 when road grants were untied are shown in Table 1.

Table 1: Commonwealth assistance to local government since 199192 ($m)

Year General purpose grants Identified roads grants Total grants Gross domestic product Total grants as share of GDP (%)

199192

715.0

303.2

1 018.1

405 795

0.251

199293

730.1

319.0

1 049.1

426 708

0.246

199394

737.2

322.1

1 059.3

449 416

0.236

199495

756.5

330.5

1 087.0

473 180

0.230

199596

806.8

358.0

1 164.7

507 096

0.230

199697

833.7

369.9

1 203.6

532 401

0.226

199798

832.9

369.6

1 202.4

564 580

0.213

199899

854.2

379.0

1 233.2

595 716

0.207

199900

880.6

390.7

1 271.3

632 391

0.201

200001

919.9

408.2

1 328.0

669 918

0.198

200102

965.8

428.6

1 394.4

711 740

0.196

200203 est

1 003.7

445.4

1 449.1

na

na

200304 est

1 044.8

463.6

1 508.4

na

na

Notes: est: estimate. na: not available. The table does not include spending under the roads to recovery program, which is shown in Table 2.

Sources: National Office of Local Government,(25) Submission to the Commonwealth Grants Commission Inquiry into the Local Government (Financial Assistance) Act 1995, p. 45 and Submission to the Inquiry Into Local Government by the House of Representatives Standing Committee on Economics, Finance and Public Administration, July 2002, p. 81. Reserve Bank statistical series, table G10. Budget Paper No. 3, 200304.

Table 1 also shows that assistance has fallen as a proportion of GDP since 199192. As noted, indexing assistance for population growth and the consumer price index maintains assistance in real per capita terms. While indexation has the effect of placing a 'floor' under the real value of assistance, it does not provide any increase in the real level of assistance even though real GDP is increasing.

The Australian Local Government Association argues that assistance should be increased and fixed at one per cent of total Commonwealth taxation receipts.(26) In 20012002, application of this proposal would have resulted in assistance of $1.498 billion compared with actual assistance of $1.394 billion.(27) However, under this proposal, the level of grants would depend on the level of economic activity and discretionary changes to taxation rates.

Interstate Distribution of Grants

General Purpose Grants

As noted, general purpose grants have been distributed among the States on an equal per capita basis since 198990, and the Commonwealth Grants Commission in 1991 concluded that it would not be appropriate to continue indefinitely this method of distribution as it departs from fiscal equalisation. This raises the question of whether the basis of distribution should be changed to one that results in fiscal equalisation.

A number of factors would have to be taken into account when considering moving from an equal per capita basis. The Commonwealth Grants Commission noted that these considerations included:

(i) The per capita basis of distribution is simple and predictable. An equalisation basis would be much more complex and would deliver less predictable outcomes, particularly in the early years.
(ii) A change to an equalisation system would entail extra administrative costs for both the Commonwealth and the States. These costs have to be considered in relation to the relatively small size of the pool.
(iii) A move to an equalisation basis would be very disruptive to local authorities in New South Wales and Victoria.(28)

The disruption attendant on a move towards equalisationthere would be winners and losersand uncertainties about outcomes militate against any attempt to adopt equalisation.

Identified Local Road Grants

Interstate Distribution

Because the interstate distribution of identified local road grants is based on the shares that prevailed when the grants were untied in 199192, the distribution is increasingly anachronistic. This distribution is based on the criteria in the Australian Land Transport Development Act 1988.

While there are no moves afoot to change the interstate distribution of road grants, and the terms of reference for the House of Representatives Committee inquiry do not specifically mention the interstate distribution, the then Minister for Regional Services, Territories and Local Government, the Hon. Wilson Tuckey, has stated:

Ideally, there should be a review of the fixed interstate shares for the local roads component of FAG's, agreed upon by the States and Territories at a Premiers' Conference in the early 1990s We will look to the Parliamentary inquiry for advice on whether to make changes to the interstate distribution of the local roads component of FAG's. Currently, no mechanism exists to periodically adjust the interstate local road shares in response to changes in local road responsibilities and changing demographics.

Combining Identified Road Grants and General Purpose Grants

Another issue is whether identified road grants should continue to be identified separately or combined with general purpose grants. As noted, the proposal that identified road grants be absorbed into general purpose grants with effect from 199596, and distributed among the States on an equal per capita basis, was rejected. No timetable has subsequently been proposed to absorb identified road grants into general purpose grants.

Views on the desirability of combining the two grants differ. On the one hand, the National Office of Local Government, for example, believes that:

local road infrastructure warrants separate identification because of the importance placed on it by local communities particularly in regional and rural Australia as well as the States and the Northern Territory and the Commonwealth Government.(29)

The Australian Local Government Association also does not favour combining the two pools:

combination of the two pools would see large changes in the distribution of the funding between the States. This would lead to volatility in the grants provided to local governing bodies. Separation of the funds is symbolic and continues to demonstrate a Commonwealth commitment towards road funding.(30)

Moreover, local governments spend more on local roads (in excess of two billion dollars annually) than is funded by identified road grants (estimated at $464 million in 200304) so that much of any additional funds in the form of general purpose grants would be likely to be spent on roads.

On the other hand, the South Australian Government favours combining the funds and allocating them on a per capita basis on the grounds that South Australia is disadvantaged under existing arrangements.(31)

Roads to Recovery Grants

In 200001, the Commonwealth began providing grants under the Roads to Recovery Act 2000 for the construction, upgrading and maintenance of roads that are the responsibility of local government. The program provides for spending of $1.2 billion over five years. This is a considerable boost to spending on local roads: in annual average terms, the program is equivalent to additional spending of $240 million, or 52 per cent of the $464 million allocated to identified road grants in the 200304 Budget. Estimated spending to 30 June 2003 exceeds $650 million. Roads to recovery grants are paid directly to local governments.

The Government decided against using the shares used to distribute identified road grants for the roads to recovery program. The distribution of roads to recovery grantswhich is based on 50 per cent road length and 50 per cent population 'adjusted to achieve some equity and fairness'(32)is unlikely to be consistent with fiscal equalisation. But the distribution of roads to recovery grants is similar, in the case of the most populous jurisdictions, to the distribution of identified road grants because both are based on similar methodologies. The differences between the roads to recovery distribution and the distribution of identified road grants are shown in Table 2.

Table 2: Distribution of roads to recovery and identified roads grants

State

Roads to Recovery (%)

Identified road grants (%)

NSW

28.3

29.0

VIC

20.8

20.6

QLD

20.8

18.7

WA

15.0

15.2

SA

8.3

5.5

TAS

3.3

5.3

NT

1.6

2.3

ACT

1.6

3.2

Sources: Prime Minister the Hon. John Howard MP and the Hon. John Anderson MP, Deputy Prime Minister and Minister for Transport and Regional Services, joint press release, 27 November 2000. Budget Paper No. 3, 2000-01.

Table 2 shows that Victoria, Queensland and South Australia gain under the roads to recovery program compared with the distribution of identified road grants.

It could be argued that the funds allocated to roads to recovery could be better used to increase general purpose grants on the grounds that local governments are best placed to determine their priorities and because they can spend general purpose grants as they wish.(33)

Minimum Grant

Section 6(2) of the Local Government (Financial Assistance) Act 1995 provides that each local government is entitled to receive a minimum grant. This section provides that the Minister, in formulating national principles, must ensure that the allocation of funds is made, as far a practicable, on a fiscal equalisation basis. But the Minister also must ensure that a local government in a State must not receive less than the amount that the local government would receive if 30 per cent of the amount to which the State is entitled were allocated among local governments in the State on a per capita basis.

The purpose of the minimum grant is to compensate local government for the narrowness of the tax base, namely, municipal rates. The grant also provides a measure of funding certainty. The number of local governments receiving the grant and the proportion of the population covered by minimum-grant local governments is trending upwards: in 199697, 45 local governments received the grant compared with 81 in 2002-03, while the proportion of the population covered rose from 15 per cent to 34 per cent over the same period.(34)

Views differ on the desirability of retaining the minimum grant. The Australian Local Government Association argues that the grant should be retained because it recognises the existence of vertical fiscal imbalance between the taxing and spending powers of the Commonwealth and local government and because it provides funding stability.(35) On the other hand, it could be argued that the grant requirement is no longer appropriate on the grounds that it improves the financial capacity of relatively wealthy local governments to the detriment of poorer local governments. As noted, the Commonwealth Grants Commission recommended that an equivalent per capita grant to every local government replace the minimum grant:

The Commonwealth could more clearly achieve its purpose of providing every local government body with a share of financial assistance by replacing the present minimum grant arrangements with an equivalent per capita grant to every local government body. This would make clear the Commonwealth's role in supporting the provision of municipal services to every citizen to at least the same level per capita. It would avoid the uncertainty arising from the present situation where the two objectives [improving financial capacity and equity] are funded from one pool.

We think that the most transparent way of implementing this approach would be to divided the present General Purpose pool into a per capita grant pool and an equity (or relative need) pool.(36)

Intrastate Fiscal Equalisation and Grants Commission Methodologies

The principle of fiscal equalisation underlies the intrastate distribution of grants, and is contained in the 1995 Act and the national principles. Section 3 of the Act defines fiscal equalisation as that allocation of funds that:

(a) ensures that each local governing body in a State is able to function, by reasonable effort, at a standard not lower than the average standard of other local governing bodies in the State; and
(b) takes account of differences in the expenditure required to be incurred by local governing bodies in the performance of their functions and in their capacity to raise revenue.

But it is questionable to what extent equalisation is being achieved. The State Grants Commissions do not use consistent methodologies to determine the intrastate allocation of grants. Moreover, it is questionable whether some of the methodologies meet the objective of fiscal equalisation:

The Act does not appear to be meeting its goal in promoting consistency in the grant distribution methodologies employed by the State and Territory Grants Commissions.(37)

It would be unreasonable not to expect grant outcomes to reflect the unique situation of each State and Territories' Local Government structure. However, it appears that the differences in grant outcomes are not solely explained by these State and Territory differences and reflect aspects of State and Territory Grants Commissions methodologies which according to the Local Government National Report are difficult to defend and not consistent with the objective of horizontal equalisation.(38)

The National Office of Local Government advocated that:

The Commonwealth Grants Commission assess the feasibility of developing, in consultation with State and Territory Local Grants Commissions, a standard framework that could be adopted by all State and Territory Grants Commissions to guide them in their application of the National Principles and their general purpose and local road grants methodologies. This standard framework would seek to promote, as far as is practical, greater consistency in methodologies between State and Territory Grants Commissions and greater consistency in the application of the National Principles.(39)

With respect to the Commonwealth Grants Commission's proposal for a relative needs pool, it concluded that decisions about how assistance should be distributed among needy local governments should be left to the judgement of the individual State Grants Commissions because of the diversity of local government needs and because the State Grants Commissions will have to balance the equity objective against the practicalities associated with having insufficient assistance to meet all of the assessed needs.(40)

Burden Shifting

Since the provision of Commonwealth assistance is not linked to specific performance requirements, local governments have an incentive to seek higher levels of funding from the Commonwealth. On the other hand, the fall in Commonwealth assistance relative to GDP may have encouraged local governments to rely more on own-source revenue and raise efficiency. As the National Office of Local Government observed:

The provision of financial support may have a negative impact on the financial capacity of Local Government over the longer term. In the absence of financial assistance grants Local Government may have been more inclined to investigate other revenue sources and pursue efficiency gains through resource sharing, amalgamations and improved financial and work practices. The 1994 Review found that where there was a significant reduction in financial assistance grants, councils typically focussed on rate substitution in the first few years and later focussed on greater efficiencies and rationalisation of services in order to keep annual rate increases in line with community expectations. This negative impact is likely to be small.(41)

The provision of Commonwealth assistance also provides State governments with an incentive to limit their grants to local government. The 1985 review of the Local Government (Personal Income Tax Sharing) Act 1976 found that some reduction in State assistance was associated with Commonwealth assistance but that it was difficult to attribute the reduction to increased Commonwealth assistance.(42) The Commonwealth Grants Commission, in its review of the 1995 Act, found that the Act seems to have had little effect on overall local government revenue raising effort.(43) What is clear is that the relative contribution of State government assistance to local government revenue has fallen: the Commonwealth Grants Commission found that although it has increased in real terms, State government assistance was about 15 per cent of local government revenue in 197475 but had fallen to seven per cent in 1997-98.(44)

Local governments contend that the States and (to a lesser extent) the Commonwealth have placed increasing responsibilities on them. The Commonwealth Grants Commission's analysis of local government expenditure over the period 196162 to 199798 supported many of these claims. The Commission also found that local governments have responded:

By placing more reliance on user charges (a trend evident in our revenue analysis), reducing expenditure in discretionary areas (particularly roads) and by increased borrowings.(45)

Conclusions

Successive Commonwealth governments have maintained the level of assistance to local government in real per capita terms and so allowed assistance to fall relative to GDP. Even so, Commonwealth financial assistance as a proportion of local government revenue has risen while State government assistance has fallen. There is no indication that the Commonwealth is likely to change the mechanism for providing financial assistance to local government: the terms of reference for the Commonwealth Grants Commission inquiry into the operation of the 1995 Act and the House of Representatives Committee Inquiry preclude examination of the level of assistance.

The contrast between Commonwealth financial assistance arrangements for the States and local government is striking. The States have access to a source of general purpose assistance, namely, the goods and services tax (GST). Revenue from the GST is likely to increase in line with growth in the economy. In contrast, local government does not have access to such a 'growth tax'. This has led, among other things, to calls for local government to be allocated a proportion of GST revenue. An argument underlying these calls is that because local government is the creation of the States, the States should be responsible for ensuring that local government has adequate funding but have failed to do so. Any move to apportion some GST revenue to local government is unlikely to succeed. The States would be likely to resist any such move, and the Howard Government's policy is not to change the GST agreement between the Commonwealth and the States and Territories.

It seems unlikely that the interstate distribution of financial assistance will be changed soon. The distribution was debated in 1999 during the negotiations between the States and the Commonwealth over the ANTS package but nothing was resolved.(46) Moreover, political considerations seem to militate against changing the methods of distribution as the former Federal Minister for Regional Services, Territories and Local Government, Senator the Hon. Ian Macdonald, pointed out to a meeting of the Local Government Association of Queensland:

the political reality is this: that there is no purpose in the Federal Government re-examining interstate distribution until the States and the Territories can agree on a common approach or until the peak body of Local Government in Australia the Australian Local Government Association, to which you all belong, can put forward a whole of Local Government submission to the Federal Government. And until you can get the States to agree, until you can get Local Government to agree, the political reality is that there is no purpose in the Federal Government re-examining that issue.(47)

A major change to the basis of distribution would entail disruption with some Statesand hence some local governmentslosing funds and others gaining: it is a zero-sum game.

Local governments seem to be increasingly caught in a 'cost squeeze'. State governments, in particular, are shifting increasing responsibilities onto local governments without providing additional commensurate revenue. The Commonwealth Grants Commission has observed:

Where the source of the financial pressure is a result of changing policies or actions of other spheres of government (the State or the Commonwealth), it would be appropriate for that sphere to acknowledge the effect of its actions on local government. Where these actions impose extra functions on local government greater financial assistance could be appropriate.(48)

It could be argued that so far, neither the State nor Commonwealth governments have met this test.

Endnotes

  1. Budget Paper No. 3 uses the term where 'general purpose assistance' when referring to general purpose grants and 'untied local road funding' when referring to identified local road grants.
  2. Commonwealth of Australia, Budget Paper No. 3, 200304, pp. 21 and 73.
  3. For a more comprehensive history, see Department of Transport and Regional Services, National Office of Local Government, 'Submission to the Commonwealth Grants Commission Inquiry into the Local Government (Financial Assistance) Act 1995', Appendix 2, 28 July 2000.
  4. Each State was required to allocate a minimum of 30 per cent of grants among local government on a basis which took account of each local authority's population, with the proviso that the States may also take account of size and population density, as well as any other matter agreed between the Commonwealth and the State concerned. The balance of assistance was to be allocated having regard to each authority's financial needs as assessed by the State Grants Commissions. Following representations by Tasmania, the issue of the percentage distribution among the States was referred to the Commonwealth Grants Commission. In its Special Report on Financial Assistance for Local Government, the Commission recommended that the distribution be changed slightly. The Premiers accepted this recommendation at the Premiers' Conference held on 1 July 1977.
  5. National Inquiry into Local Government Finance, Report, AGPS, 1985.
  6.   P. Self, 'The Federal Government's Role in Local Government Finance', in G. Brennan, ed., Local Government Finance, Centre for Research on Federal Financial Relations, Australian National University, Occasional Paper No. 41, p. 9, Canberra, 1987.
  7. Defined as the sum of financial assistance grants, identified health grants and general purpose capital assistance.
  8. The Act provided that no local authority would receive an amount less than the amount it would receive if 30 per cent of the State's grant were allocated on an equal per capita basis.
  9. Commonwealth Grants Commission, 'Report on the Interstate Distribution of General Purpose Grants for Local Government 1991', AGPS, 1991.
  10. ibid. p. xxv.
  11. ibid. p. xxii.
  12. The term 'identified' is used because they are separately identified from general purpose grants, which are allocated among the States on a different basis from road grants.
  13. Budget Paper No. 3, 199596, p. 33.
  14. In essence, these criteria were designed to reflect relative road needs.
  15. Australian Urban and Regional Development Review, 'Financing Local Government. A Review of the Local Government (Financial Assistance) Act 1986', Discussion Paper #1, February 1994, and Local Government Funding Methodologies, November 1994.
  16. As noted, constitutional responsibility for establishing local government lies with the States. Indeed, the Constitution does not mention local government even though local government existed long before Federation. All State and Territory jurisdictions have passed legislation establishing local governments except the Australian Capital Territory (ACT), which has both State-like and local government functions. The ACT has received assistance for local government functions since 198889.
  17. Prime Minister, 'Changes to the goods and services tax', Media Release, 31 May 1999.
  18. In 1997, the Commonwealth imposed surcharges on the excise on tobacco, alcohol and petroleum after the High Court cast doubt on the constitutional validity of all State franchise fees. The Commonwealth returned the surcharge revenue to the States as revenue replacement payments. These payments ceased on 30 June 2000 with the introduction of the GST.
  19. This is consistent with the decision that the consumer price index estimate, excluding the effect of tax reform, be used for indexation purposes for most Commonwealth expenses including specific purpose payments. Automatic escalation of grants is not guaranteed since the 1995 Act provides the Commonwealth with discretion to adjust the escalation factor to suit its budgetary or other circumstances.
  20. Arthur Andersen, 'Impact of GST on Local Government', Report prepared for the Victorian Department of Infrastructure and Department of Treasury and Finance, August 1999.
  21. Commonwealth Grants Commission, Review of the Local Government (Financial Assistance) Act 1995, June 2001.
  22. The Hon. Wilson Tuckey MP, Minister for Regional Services and Local Government, 'Local Government Inquiry to Look at Cost Shifting', media release WT29/2002, 30 May 2002.
  23. Department of Transport and Regional Services, 'Submission to the Commonwealth Grants Commission Inquiry into the Local Government (Financial Assistance) Act 1995', p. 15.
  24. The National Office of Local Government is the unit in the Department of Transport and Regional Services responsible for, among other things, providing the Minister for Regional Services, Territories and Local Government with advice on matters relating to local government.
  25. Australian Local Government Association, 'Initial Submission to the Commonwealth Grants Commission's Discussion Paper CG 2000/1', p. 8. Available at: http://www.cgc.gov.au/australian_local_government_association.htm
  26. Commonwealth Treasury, 'Final Budget Outcome 20012002', pp. 4 and 49.
  27. Commonwealth Grants Commission, op. cit., p. xxv.
  28. Department of Transport and Regional Services, op. cit., p. 35.
  29. Australian Local Government Association, op. cit., p. 21.
  30. South Australian Government submission to the Commonwealth Grants Commission Review of the Commonwealth Local Government (Financial Assistance) Act 1995, p. 16.
  31. Senator the Hon. Ian Macdonald, Minister for Regional Services, Territories and Local Government, Senate additional estimates hearings, 1 December 2000, at RRA&T 153.
  32. This argument is an example of the 'choice' model, which holds that local government better reflects community wishes than centralised government. The Government's decision on roads to recovery is an example of the 'agency' model, in which local government is seen as the vehicle for implementing central government decisions.
  33. Department of Transport and Regional Services, National Office of Local Government, Local Government National 2001-02 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p. 46.
  34. Australian Local Government Association, op. cit., p. 17.
  35. Commonwealth Grants Commission, Review of the Local Government (Financial Assistance) Act 1995, June 2001, p. 37.
  36. Department of Transport and Regional Services, op. cit., p. 26.
  37. ibid. p. 34.
  38. ibid. p. 6.
  39. Commonwealth Grants Commission, Review of the Local Government (Financial Assistance) Act 1995, op. cit., p. 37.
  40. Department of Transport and Regional Services, op. cit., p. 16.
  41. ibid. p. 29.
  42. Commonwealth Grants Commission, Review of the Local Government (Financial Assistance) Act 1995, op. cit., p. 51.
  43. ibid. p. 50.
  44. ibid. p. 53.
  45. Senator Hon I. Macdonald, Minister for Regional Services, Territories and Local Government, 'Address to the Local Government Association of Queensland Annual Conference', 27 July 2000, http://www.dotrs.gov.au/media/macdon/speeches/ms13_2000.htm
  46. ibid.
  47. Commonwealth Grants Commission, Review of the Local Government (Financial Assistance) Act 1995, op. cit., p. 55.

Appendix 1

Terms of Reference for the Review of the Local Government (Financial Assistance) Act 1995

The review under Section 17 of the Local Government (Financial Assistance) Act 1995 will examine and report on:

a) the effectiveness of the current arrangements under the Act to achieve the

purposes of the Act and the goals in providing the grants that are referred to in

Section 3 of the Act;

b) the appropriateness of the current National Principles and, in particular, the

retention of or variations of the minimum grant for the general purpose

component in Section 6 of the Act;

c) the consistency with the National Principles of the methodology and policies used

by each of the State and Territory Grants Commissions in distributing funds to

councils;

d) As required by Section 17 of the Act, the review shall also examine and report on:

(i) the effectiveness of the arrangements under this Act in relation to ensuring

that the allocation of funds for local government purposes is made on a full

horizontal equalisation basis as mentioned in paragraph 6(2)(a); and

(ii) the impact of the Act on the raising of revenue by local governing bodies and

on the assistance provided by the States to local governing bodies; and

(iii) the implications of any changes in the functions or responsibilities of local

government bodies; and

(iv) the eligibility for assistance under this Act of bodies declared by the Minister

under Section 4 to be local government bodies.

The Review will not address the interstate distribution of the general purpose and local road grants or the quantum of funds available under the Act.

Appendix 2

Standing Committee on Economic, Finance and Public Administration. Inquiry into Local Government and Cost Shifting, terms of reference.

The Minister for Regional Services, Territories and Local Government has asked the Committee to inquire into: cost shifting onto local government by state governments and the financial position of local government. This will include an examination of:

1. Local government's current roles and responsibilities.

2. Current funding arrangements for local government, including allocation of funding from other levels of government and utilisation of alternative funding sources by local government.

3. The capacity of local government to meet existing obligations and to take on an enhanced role in developing opportunities at a regional level including opportunities for councils to work with other councils and pool funding to achieve regional outcomes.

4. Local government expenditure and the impact on local government's financial capacity as a result of changes in the powers, functions and responsibilities between state and local governments.

5. The scope for achieving a rationalisation of roles and responsibilities between the levels of government, better use of resources and better quality services to local communities.

6. The findings of the Commonwealth Grants Commission Review of the Local Government (Financial Assistance) Act 1995 of June 2001, taking into account the views of interested parties as sought by the Committee. The inquiry is to be conducted on the basis that the outcomes will be budget neutral for the Commonwealth.

 

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